Employee Share Option Plan (ESOP)

An Employee Share Option Plan (ESOP) is a type of equity remuneration incentive scheme that allows a company’s employees to acquire shares in the company or its holding company. These schemes are a form of employee benefit, where compensation includes elements covered by FRS 102 Share-based Payment.

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Here’s a detailed breakdown of ESOPs based on the sources:

• Nature and Purpose
  • ESOPs, or “share acquisition schemes,” include stock options and share awards, along with other similar employee share purchase plans. They are a means for employees to gain an ownership interest in the company.
  • Such schemes are part of an employee’s remuneration package, serving as an incentive for employees to remain with the entity or to reward them for improving the entity’s performance.
  • The aim is to reflect in the company’s financial statements the effects of share-based payment transactions, including expenses related to share options granted to employees.

• Mechanism and Operation
  • An ESOP typically involves the granting of rights or benefits to employees to acquire shares. This can include rights to subscribe to the company’s shares at a fixed or determinable price for a specified period.
  • The acquisition of shares can occur directly from the company through allotment and issue, or through the purchase of shares from an existing shareholder.
  • Treasury shares (shares previously bought back by the company) can be transferred to persons under an ESOP. A company may also acquire previously issued shares from a stock exchange or other persons for this purpose through a special purpose vehicle (SPV).
  • ESOPs often have vesting conditions, such as requiring the employee to remain with the company for a specified period or achieving a performance target.
  • For public companies, the issue of shares with different voting rights under such schemes generally requires the special, limited, or conditional voting rights to be specified in the meeting notice.
  • Shareholder approval is typically required for employee share option schemes, especially for listed companies and those involving subsidiaries. Directors may be empowered by resolution to issue and allot shares for such purposes.
  • The scheme’s terms may allow for modification or amendment, provided it adheres to relevant bye-laws and approvals.

• Financial Assistance and Solvency
  • While public companies generally have restrictions on providing financial assistance for dealings in their shares, employee share ownership schemes are a specific exception.
  • Payments for share repurchases (which can be part of an ESOP if treasury shares are acquired) must only be made if the company is solvent. A solvency statement from directors is required for certain share capital reductions or financial assistance.

• Accounting Treatment (FRS 102)
  • Entities apply FRS 102 Share-based Payment for accounting for ESOPs.
  • The fair value of employee services received is measured by reference to the fair value of the equity instruments granted.
  • For share options, if market prices are not available for similar traded options, an option pricing model(like Black-Scholes-Merton) is used. Factors like expected early exercise (due to non-transferability or cessation of employment) and expected volatility are considered in this valuation.
  • Vesting conditions (other than market conditions) are accounted for by adjusting the number of equity instruments, not by adjusting their fair value at the measurement date.
  • An ESOP can be equity-settled (where the entity receives services for its own equity instruments) or cash-settled (where the entity incurs a liability to transfer cash based on the equity instrument’s price, such as with share appreciation rights).
  • Disclosures in financial statements include a description of the arrangements (vesting requirements, option terms, settlement method), the number and weighted average exercise prices of options (outstanding, granted, forfeited, exercised, expired), the weighted average share price at exercise, and information on how fair value was measured. The total expense recognised from share-based payment transactions must also be disclosed.
  • Directors are considered employees for the purpose of this standard.

• Tax Implications
  • Gains or profits derived by an individual from a right or benefit to acquire shares obtained by reason of any office or employment are generally chargeable to tax.
  • However, specific tax exemptions for gains or profits from equity remuneration incentive schemes have been provided under the Income Tax Act for certain periods:
    • SMEs (Section 13H): Exempts gains from stock options (granted June 2000 – Dec 2013) or share acquisition schemes (granted Jan 2002 – Dec 2013) after a minimum holding period, for qualifying employees.
    • General Scheme (Section 13I): Similar exemptions for a broader range of companies, subject to a $1 million aggregate cap on exempted gains and a “relevant percentage requirement” for employee offers.
    • Start-ups (Section 13J): For schemes granted Feb 2008 – Feb 2013, 75% of gains can be exempt for qualifying employees.
    • These exemptions do not apply to gains or profits derived on or after 1 January 2024.
  • A company can claim a deduction for the cost of acquiring treasury shares transferred to a person under an ESOP (stock option or share award scheme). Similar deductions are available if shares are transferred via a special purpose vehicle (SPV).
  • Expenses incurred by a company for share acquisition rights granted to employees by reason of employment are deductible, unless they relate to treasury shares or shares for which a deduction is already allowed under Section 14M(7).
  • “Share acquisition scheme” for tax purposes imposes a minimum holding period requirement of at least one year if shares are at a discount to market value, or at least six months if the price is equal to or exceeds market value.
  • “Shares” in this context include stocks but exclude redeemable, convertible, or preferential shares.

• Regulatory Oversight
  • The Singapore Exchange (SGX) plays a role, with listing rules requiring shareholder approval for employee share option schemes, even those involving subsidiaries.
  • For listed companies, the relevant rules regarding ESOPs are found in Chapter 8 (“Changes in Capital”) of the SGX Listing Rules, specifically under “Share Option Schemes or Share Schemes”. These rules cover the terms of the schemes, shareholder approval, size limits, and disclosure requirements.
  • The Securities and Futures Act (SFA) may exempt offers of securities to qualifying persons like employees under ESOPs from prospectus requirements, subject to specified conditions.

In summary, an ESOP is a strategic tool for companies to incentivise and compensate employees by providing them with an ownership stake, with specific accounting and tax regulations governing its implementation and disclosure.